Sunday, 21 October 2012

Austerity, debt burdens and hypocrisy

After the weekend march against UK austerity, I
saw a government minister on the TV justifying their fiscal plans. One of the
arguments he used was that it was necessary for the sake of our children. In
these circumstances I can quite understand the urge to dismiss such arguments
as invalid. Part of this urge comes from knowing that, in many cases, the
argument about debt being a burden on future generations represents simple
hypocrisy.

How do I know this? Because often exactly the same people championing
austerity also argue
that we cannot take action to reduce future climate change because the current costs
will be too great. The UK government’s spin
was that it would be the greenest government ever, but its policy is quite the opposite. The
Republican Party in the US also resists any action to reduce climate change
because of the current costs of doing so (at least when they are not denying
climate change exists). The connection? Both issues involve trading off costs
to the current generation (austerity, measures to reduce climate change) with
costs to future generations (higher taxes, climate change itself). If you
really believe that we must reduce debt right now (rather than after the
economy has recovered) because of the impact debt will have on future
generations, then you should also be doing everything you can right now to
reduce carbon emissions.

But just because some of those who use the ‘we are doing it
for our children’ argument to justify today’s austerity are doing so
hypocritically does not mean the argument is wrong. I will not go over why it
is not wrong again,
except to stress a point I do not think I have made forcefully enough before. Arguments
which look at the distributional implications of permanently higher government debt
(debt incurred but never repaid), and then ponder whether real interest rates will
or will not be higher than the growth rate, are analytically convenient but
practically irrelevant. There are many strong reasons, which have nothing to do
with intergenerational equity, why it would be foolish to not try and reduce
the high levels of government debt we currently have when the economy recovers,
and so additional debt issued today will need to be repaid (and not just financed) at some point in the not too distant
future.

However, although concerns about intergenerational equity
are valid, they are unlikely to be critical to the austerity debate. Probably
most major economic issues involve some element of redistribution, and in
practice the device
of compensating the losers is not an option. Take monetary policy, for example.
We currently have low real interest rates, which benefits some but harms
others. Do we let the fact that savers are worse off as a result of this policy
hinder the central bank from keeping interest rates low? Of course not.

In the case of reducing debt today through austerity, there
are other factors which have distributional consequences going in the other
direction. To the extent that we have austerity through lower investment in
infrastructure or education, it is the young more than the old that will be
hurt by this policy. As important, high unemployment among the young today can
have lasting effects (pdf, HT TC) on their welfare, and their children's welfare, as this study (pdf) shows. More generally, if DeLong
and Summers are right that the hysteresis effects of austerity today are
significant, then an entire future generation may be worse off as a result.

So it is not that ‘burden of debt’ arguments are wrong, but
that they are just not that important in the context of the current austerity
debate. The welfare loss to future generations of delaying debt reduction by
ten years is small relative to the massive loss of resources and welfare caused
by austerity today. If we are worried about future generations, a far cheaper
way of helping them is to take action to mitigate the impact of climate change.

7 comments:

You say, “it would be foolish to not try and reduce the high levels of government debt we currently have when the economy recovers..”.

I rather feel you are condoning the view taken by the economically unsophisticated, namely that national debt should be treated like household debts: i.e. “something that needs to be reduced”. Isn’t the view taken by Keynes the correct one, i.e. “Look after unemployment and the budget looks after itself” – (which implies that the debt looks after itself)?

I.e. if the private sector decides it wants to hold a significantly larger amount of Gilts over the next fifteen years than over the last fifteen, why not let it? As long as government continues to pay a zero real rate of interest, I see no harm. In fact if the private sector is PREVENTED from doing that, we’ll get paradox of thrift unemployment: the private sector will try to save liquid assets (monetary base or government debt).

Personally I’d aim for a small negative real rate of interest: that way we make money out of foreign holders of Gilts. I.e. we sort of supply them with bits of paper in exchange for real goods and services. Put another way, if the world wants us to act as banker (which it does to some extent), that’s great. Let’s supply the service that they want, and make a profit at the same time.

In my view, the problem is sustainability of demand for government debt. Until investors are willing to take peaces of paper in exchange for real goods and services there is no problem. Japan is doing fine with debt to GDP level around 200%. If the mood changes for the worse however, it is not clear if the government is willing to expose its constituency to the consequences of such policies. If the government cannot sell bonds on the market to retire old debt there are only two ways to tackle it. Debt monetisation (inflation), if there is a willing central bank in sight, or default. We can see that small nations at least are exposed to such risk. The real question is who is big enough not to worry...

Great post, I agree with what you are saying, but I think there is one important caveat.

I think that when economists talk about burden of debt, we are talking about one of three things 1)in the future, collectively as a nation, we will be poorer (can afford fewer consumption or investment goods) than we otherwise would be, 2) a cohort, possibly living now (but younger) or to be born in the future will have lower welfare than otherwise, 3) (since Miran brings it up) there could be a future run on government debt.

I would argue that 1) is the view that many politicians/economic layman have on the issue of debt; moreover this is the view that Krugman/Noah Smith/Dean Baker are fighting--because this view is absolutely wrong!--and so we point out correctly that debt is a pure transfer payment.

I would argue that 2) is the point that Nick Rowe likes to make, but talking to non-economists, I just don't think regular people understand this as the cost of debt--most people think the problem with debt is 1). I think its a helpful corrective for us economists remember your point that 2)--which is the "debt burden" that you are talking about as well--is a cost which is small compared to other considerations.

For completeness, I want to also say that Miran's point (#3), is just wrong. Sorry Miran, but its true. A country with its own currency that gets into debt trouble only needs to devalue or run a primary budget surplus. The argument that we have to cut now, so that we don't have to cut or devalue later is just nonsense.

So, I think we are left with the conclusion that the only cost of debt worth worrying about--which is really important cost!--is the crowding out of investment by debt. This is importantly not an issue in the middle of a depression.

If the children are the main concern of these politicians as much as they say they are,then they need to ask themselves how are these austerity policies helping the children of today never mind tomorrow.Cuts in tax credits if you cant get 24hrs work a week,increased from 16. Stagnant or falling wages,increases in VATresorting in parents going to food banks to put a meal on thetable. Combine all this with little or no job prospects for 18-24yr olds and one is left with a situation of neglect of a generation because of an ill conceived philosophy of what will happen to the next.Let's sort the present before we sort the future.

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